Pakistani shares fall on expectations of a rate hike

PolyaLesova

NEW YORK (MarketWatch) -- Pakistani equities fell sharply Monday as traders bet that the central bank will raise interest rates aggressively tomorrow in order to fight skyrocketing inflation.

In Karachi, the KSE-100 benchmark stock index fell 4.1% to end at 10,578 points. It has fallen 24.9% this year.

"More and more people are speculating that the government will raise interest rates tomorrow," said Arpitha Bykere, an analyst at RGE Monitor. "That is a big negative for the stock market. That will impact corporate earnings."

At the same time, Bykere emphasized that the expected interest rate hike is "extremely necessary, because inflation now is in double digits."

Pakistan's consumer price inflation accelerated to a 30-year high in June. It rose 21.53% from a year earlier.

The State Bank of Pakistan, the country's central bank, has raised its discount policy rate twice this year by a total of 200 basis points to 12%.

Real interest rates in Pakistan are negative, Bykere said, adding that the recent increase in domestic fuel prices is likely to boost inflation further in the coming months. Government spending has been rising recently, while the investment boom in the country is turning into a bubble, she said.

"Monetary tightening tomorrow will be a medicine to fight all these risks," Bykere said. "The action from the central bank will help restore investor confidence in the country."

Roller-coaster ride

Investors in Pakistan have had a roller-coaster ride this year. In the first few months of 2008, the KSE-100 was the best performer among major emerging markets indexes. However, since April 18, when the index soared to a record high of 15,676 points, it has tumbled 33%.

The Pakistani market's precipitous decline prompted regulators to put in place market stabilization measures in late June, but a few weeks later they reversed most of these rules, triggering another sell-off.

In mid-July, more than 200 protestors attacked the Karachi Stock Exchange and demanded a temporary closure of the market to curb further drops in share prices. Read more.

Last week, officials announced the formation of the 20 billion Pakistani rupees Equity Market Opportunity Fund, which improved investor confidence.

"For me, the market still represents excellent value, with a dividend yield of 8.3%," said Rupert Neil Bumfrey, an advisor to emerging markets asset-management companies.

"With the continuing agitation for the reinstatement of the 'deposed' chief justice, plus an impasse over this issue by the [government] coalition partners, who increasingly seem like a divorcing couple ... you have a recipe for turmoil, but that is Pakistan," Bumfrey said.

"A day's movement back by 4% is nothing when you consider market capitalization is above the low of $45 billion that was hit recently," he said. Monday's market cap was $46.38 billion.

Pakistani PM visits U.S.

In Washington Monday, Pakistani Prime Minister, Yousuf Raza Gilani, met with U.S. President George W. Bush, who said Pakistan was a strong ally in the fight against terrorism and is committed to securing its border with Afghanistan, the Associated Press reported.

Gilani's visit to the United States comes at a "critical" time for Pakistan, wrote Imtiaz Gadar, head of research for Pakistan at JP Morgan, in a note Monday.

"Domestically, political noise is at relatively high ebb, external pressure is mounting for an increased role in the war on terror and the economic pressures have meant that external support for financing of budgetary and external accounts is crucial," Gadar said.

"Positive developments especially in terms of aid or soft loans would be welcome by the market as it would not only signal smooth relations with U.S., it would also help ease pressure on external accounts and hence currency," said Gadar.

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